“Is a pension better than an ISA or an ISA better than a pension?”
On the face of it, that should be a simple question to answer but, like many things in life, it depends. ‘Better’ is a subjective term; ‘better’ how? Is an Aston Martin DB9 better than my Skoda Octavia estate? If I want to present an image of wealth and success or get from my home in Devon to Birmingham in greater style and comfort then, undoubtedly the Aston is better. But what if I want to take my family and all their paraphernalia to Birmingham as economically as possible? In that context, my Skoda is much more fit for purpose than James Bond’s car of choice.
So what about the pension or the ISA? (to be clear, the comparison here is with Cash ISAs and Share ISAs rather than Help to Buy or Lifetime ISAs)
The benefits of a pension are:
- Currently, up to £40,000 can be contributed to a pension in any single year (but this depends upon your income and previous years’ contribution history).
- Personal contributions benefit from a supplement from the Government called Tax Relief. They add 20% of the contribution to the pension fund and higher and additional rate taxpayers can claim back additional income tax paid via their annual self-assessment.
- Other people including employers and family members can contribute to the pension too.
- If you didn’t contribute in previous years it may be possible to ‘carry-forward’ contribution entitlements from those years.
- The invested fund grows free of tax with 25% of the fund being available tax-free at retirement.
- Unlike ISAs, pension funds are outside of the taxable estate for inheritance tax purposes.
The benefits of an ISA are:
- Regardless of your earnings, up to £20,000 can currently be contributed to an ISA in a tax year. With a pension, you can only contribute the lower of £40,000 or 100% of earnings in a tax year so if your earnings are less than £20,000 you can save more into an ISA.
- The capital can be accessed at any time regardless of age (pensions are inaccessible until 55 for most people).
- They can be used to provide a tax-free income and the whole fund is tax-free when they are cashed in.
- Unlike pensions, there is no limit on the size of the ISA fund you can accrue without a charge being levied (known as the Lifetime Allowance for pensions)
So, you can see there is no clear answer to whether an ISA is better than a pension or vice versa. It really depends upon your circumstances; if you are a low-earner, with spare cash to invest but may need it before you are 55 the ISA may be more appropriate. On the other hand, if you are a higher rate taxpayer who wants to reduce their income liability a pension contribution may be preferable.
As is often the case the most suitable approach may be to do a bit of both but always in the context of your unique position and short, medium and long-term lifetime priorities.
If you would like to talk about your pension and ISA choices contact me: https://neliganfinancial.co.uk/contact-us/